Six top share picks with 29% upside

Perhaps tired of the negative narrative dominating the past fortnight, financial markets look much more optimistic this week. True, it's been confirmed that businesses have stopped investing as much since Brexit, and domestic UK stocks have been treated harshly, but as the dust settles, some pearls of value have been found amongst the wreckage.

Global growth forecasts have been cut by 0.5 percentage points, with analysts at Barclays forecasting a 2017 UK recession and meagre 0.6% euro area growth. As analysts scramble to adjust financial forecasts in response to Brexit, average earnings guidance has been cut by 2.6% for 2016 and 6% for 2017, pulling average share price target down by 10.5%.

But, as the countervail prescribes: it's not all bad.

Not only will the weaker pound support UK exporters, but pockets of value have emerged among oversold cyclical and growth stocks, triggering upgrades in the diversified financials, media, tech hardware and oil services sectors. The post-Brexit popularity for staples and healthcare is set to remain for some time, too, argues Barclays.

A list of the broker's 29 European top picks made its way into our inbox first thing - and the headline figures are impressive. The portfolio of tips offers a potential 32.4% total return over the next 12 months, plus a prospective dividend yield of 3.1%. After the post-Brexit equity exodus, the portfolio also looks decent value on a 2017 price/earnings (PE) multiple of 14.8 times, while generating a free cash flow yield of 7%.

The portfolio's exposure to both UK and continental stocks is split evenly and features industrials Linde, Boliden, Safran and BMW, in addition to Vestas Wind Systems and AENA. Consumer group Ahold also made the list, joined by financial giant ING, healthcare group Grifols, media company RELX, retailers Luxottica, technology firms SAP and Nokia, and phone network Orange.

We look at the six London-listed stocks with the largest upside, according to Barclays, offering an average potential capital return of 29%.

Imperial Brands

Consumer

Replacing British American Tobacco as Barclays' top European Beverages & Tobacco pick, Bristol-based Imperial Brands' (formerly Imperial Tobacco) growing organic sales momentum and margin/cash generation should support double-digit dividend growth in the mid-term.

In addition to high barriers to entry, the tobacco sub-sector has a protected profit pool, which is attractive given competition elsewhere in staples. Early signs that Imperial is able to plug share losses are encouraging, with the US stabilising since November and Winston and Kool brands expanding.

There'll be headwinds in 2016 with the loss of its PMI distribution contracts, EU regulation costs and currency, but mid-term margins are set to grow - its brand migration strategy is ahead of expectations.

With a target price of 4,400p, the shares have 8.4% upside from 4,058p currently. The shares trade on 16.5 times forward earnings, not too demanding given projected earnings growth of 13%.

Ophir Energy

Energy

The oil sector was sent into a tail spin in the summer of 2014 as oversupply pushed energy prices off a cliff. Some are still reeling from the sell-off, but there are pockets of serious value here.

While BP and Petrofac have jaw-dropping upside of 34% and 58.3% respectively, Ophir takes the lead with a target price of 123p reflecting 74% of untapped value.

Investors are naturally cautious over management's desire to resume exploration activity and have been questioning the quality of the Fortuna floating liquefied natural gas (FLNG) project in Equatorial Guinea, which has caused it to underperform its European peers - it now trades at a 47% discount to Barclays' tangible net asset value (TNAV) versus a peer group average of minus-18%.

But first gas is still on track for 2020, as its strong project economics allows Ophir to sanction without reducing its stake. Its exploration programme also identifies opportunities with returns below $50 per barrel of oil equivalent (boe) across a reasonable time. Barclays wouldn't be surprised if a 2-3 well campaign is launched in Myanmar and Cote d’Ivoire next year.

Derwent London

Financial services

Pipping Prudential to the post with 34% upside, Barclays reckons the largest real estate investment trust (REIT) focussed on central London, Derwent London, is worth 3,500p. It has consistently outperformed its UK REIT peers, with returns well above the London office market.

"To assemble a portfolio valued at £800 per sq ft would be a challenge in today’s investment market," said the analysts. "With what we consider to be the most experienced management team in the sector and trading on a c.30% discount to spot NAV, we see Derwent's current valuation as attractive."

Of course, recent uncertainty is going to hit demand, but limited supply should mean rents fall less than the market is pricing in. The group also delivers market-beating returns thanks to its focussed business model, consistent strategy and conservative balance sheet management. It’s also an excellent developer with a flexible pipeline.

Redrow

Industrials

Housebuilder Redrow comes out on top of the industrials sector, as it continues to invest for future growth to capitalise on the current housing cycle. There are big potential macro-economic potholes ahead, but Barclays reckons the cycle still has a way to run with many of these trends positive.

You aren't going to get the big dividends you find elsewhere in the sector, this stock should reward investors looking for long-term growth.

With a target price of 364p, the shares offer investors a potential 12% upside and don't look too expensive with a PE multiple of five times. The group leap-frogged scientific kit manufacturer Oxford Instruments, equipment rental company Ashtead and heating and plumbing firm Wolseley.

SSE

Power & Utilities

Yielding an attractive but sustainable 6% and with a diversified and balanced business mix, SSE is clearly Barclays' top pick for European Utilities. The analysts reckon there should be upside from current wholesale commodity price weakness, with the company enjoying growth from its organic renewables and regulated networks. Recent risks to retail have also been removed, with recent CMA Energy Market Investigation recommendations and the government's move to index the UK Carbon Price Support.

Barclays reckons the shares are worth 1,650p, which is 5% above its current 1,559p share price.

Paddy Power Betfair

Retail

As a multi-year growth story and with strong free cash flow and capital returns, Paddy Power Betfair is Barclays' top pick in European Leisure - overtaking online retailer ASOS and entertainment group Cineworld. Earnings growth should be strong over the next few years, with high operational gearing and no balance sheet restraints.

Says Barclays: "The reason we like PPB is straightforward: two leading brands operating in structurally growing markets, with a strong management team and leading technology platform that can benefit from centralised technology and resources to develop new products to segment and target consumers in order to take market share. We view scale as crucial in this sector."

The shares have a £115 price tag, offering 38% upside to current levels.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.